Camille Van Vyve
26 Jul 2022
Stories of crises and recoveries: Black Monday
On Monday, October 19, 1987, investors around the world watched with horror as the markets collapsed by more than 20%, first in Asia, then in Europe and finally in the United States. A panic attack caused by a combination of anxiety-provoking events that was extremely violent…but fortunately of fairly short duration.
What is the context?
From 1982 to 1987, the stock market more than tripled in value. In 1987 alone, before the crash, it increased by 44%... But in the United States, a slowdown in the economy and exports was felt. Added to this are fears about the rise in the price of oil and inflation: little by little, the signals are changing from green to orange, urging investors to be cautious and pushing them to protect the gains made until here.
Before Black Monday, a red week
In October 1987, warning signs had been appearing for a few days: on Wednesday October 14, the Dow Jones lost 4%, and on Friday October 16, the London stock market fell by 5% following a devastating storm. In this week alone, the world markets lost 9%: it is no longer the fear of a correction but a smoldering panic.
Automated trading, the novelty
Moreover, with the rise of computers in the 1980s, automated trading began to develop. Software now makes it possible to automatically execute sell orders when a certain level of decline is exceeded on a security. Given the context, investors were more than ever ready to press the button.
Incriminated portfolio insurance strategies
Also innovative at the time, portfolio insurance strategies use this same mechanism. It involves large institutional investors hedging the risk of their equity portfolios by shorting futures positions - that is, selling them in the hope of buying them back later at a lower price.
Black Monday, the big storm
Monday, October 19, 1987, as the Tokyo Stock Exchange opened lower, a series of automated sell orders began, giving rise to a domino effect across all stock exchanges. The pace of sales is constantly accelerating, further reinforcing the fall in prices: this is the vicious circle.
Quick recovery
While the violence of Black Monday made a strong impression, the markets recovered fairly quickly. Five months after the crash, three quarters of the losses observed on the world market have been erased. It took a year for the gap to be completely closed and for a new decade of almost continuous bullishness to open up in the markets.
Safeguards put in place
It is after this episode that the famous “circuit breaker” mechanisms were put in place. It aimed at interrupting transactions on a given security or index for a fixed period, when a certain level of decline is exceeded. Even if these mechanisms are debated given the obstacle they constitute to market efficiency, they were still used during the Covid crisis several times in March 2020 on the New York Stock Exchange (NYSE).
Read other episodes in this series about market crashes and recoveries : the tulip crisis , the Gulf War, the Greek debt crisis